Moody's Downgrades FGIC

Moody's Investors Service on Thursday was showing no love for Financial Guarantee Insurance Co., downgrading the troubled bond insurer to A3 from triple-A.

The closely-held company, whose investors include the Blackstone Group ( BX), has suffered along with rivals MBIA ( MBI) and Ambac Financial ( ABK), as the ratings agencies grow increasingly wary of their ability to guarantee the debt they insure.

"These rating actions reflect Moody's assessment of FGIC's meaningfully weakened capitalization and business profile resulting, in part, from its exposures to the U.S. residential mortgage market," Moody's said in a press release announcing the downgrade.

Moody's said FGIC remains on review for possible downgrade, as the rating agency keeps an eye on its plans to raise capital. Moody's warned an "unfavorable outcome" could result in a cut to the Baa level.

Fitch Ratings last month downgraded FGIC and Ambac to double-A from triple-A.

Moody's, however, said while MBIA and Ambac remain on review for possible downgrade, both "are better positioned from a capitalization and business franchise perspective." MBIA on Wednesday raised $1.1 billion through a sale of 94.6 million shares of common stock. Private equity firm Warburg Pincus added $300 million to the $500 million stake it took last year.

Downgrades to bond insurers would be devastating, as their pristine credit is critical to their core business of insuring municipal and corporate debt. Of particular concern are risky collateralized debt obligations, or CDOs, and other asset-backed paper the companies have increasingly insured in recent years. As the risk for default of the underlying mortgages has increased amid the housing slump and credit crisis that began last summer increased, so too did the risk the bond insurers will have to pay claims.

If the bond insurers themselves are downgraded, the debt they backstop also faces downgrades. That makes the debt unsuitable for some institutional investors.

As the crisis has mounted, both government and the financial sector have scurried to formulate plans to avoid catastrophe. Earlier on Thursday, a subcommittee of the House Committee on Financial Services hosted a hearing entitled "The State of the Bond Insurance Industry."

In that hearing, New York state Insurance Superintendent Eric Dinallo floated a plan to separate the municipal debt and structured debt backed by the bond insurers to protect municipal bond holders and restore the guarantors' triple-A ratings.

The hearing also featured testimony from New York Gov. Eliot Spitzer and officials from the Securities and Exchange Commission, Federal Reserve and Fitch Ratings. It also pitted MBIA CFO Charles Chaplin and Ambac President and CEO Michael Callen on the same panel as hedge fund manager Bill Ackman, who has been betting on the bond insurers to fail since at least 2002.

MBIA fired back at Ackman at the hearing, saying his cage-rattling has been misleading and intended to support his short position.

Earlier this week, billionaire investor Warren Buffett offered to provide a second level of insurance to $800 billion in municipal bonds backed by the bond insurers. Ambac has publicly refused the offer and sources tell TheStreet.com MBIA has done the same.